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Commentary: Don’t Mindlessly Accept Old Relics Of Financial Advice — Including Home Ownership

I firmly believe that the financial collapse of 2008 and its ongoing aftermath (i.e. persistent unemployment above 8 percent, arguably the worst recession in 70 years, the evaporation of trillions of dollars of home equity, decimation of 401(k) balances and more) calls for an open minded re-evaluation of previously commonly accepted financial assumptions, such as the following:

• Put the maximum that you can afford into your 401(k) or other retirement plans, invest in a diversified manner and adopt the long-term view.

• Ride out the volatility of the stock market, because over a decade or more, the stock market has always outperformed other investment asset classes.

• Buying a home is the best investment you will ever make.

My most recent column urged readers to thoughtfully consider if the last piece of above listed generic advice is still valid in the post 2008 financial landscape. Buying a home obviously is not a risk-free undertaking, and it is far from being a no-brainer for most Americans. One financial adviser in a 2002 column urged readers considering homeownership “to get in early and as aggressively as possible.” Who was that enthusiastic guy? Yours truly! With the benefit of hindsight, perhaps I was a little too bullish on the housing market 10 years ago.

Please hear me clearly. I am not saying that owning a home versus renting is no longer a sensible choice for the majority of Americans. What I am saying, actually screaming, is that in this “new normal” world of crushed housing values and low interest rates, you should not mindlessly accept old relics of financial advice.

“Is home ownership financially smart in current market?” was the headline of my last column. Well, is it? Let’s take off the rose-colored glasses and review a few of the old assumptions that implied that home ownership was truly a no-brainer.

• Home values will steadily increase over time, thus building equity and providing a hedge against inflation. This certainly has not been true for the last few years. There is an old saying that all real estate is local, and that only three things matter: location, location and location. Some local residential markets now appear to be rebounding while others may not have found a bottom yet. Consider the opposing views of two “expert” sources found online. Just a few days ago, online real estate firm Zillow (www.zillow.com) declared a bottom had been reached for home prices nationally. Not so fast, according to Michael Feder, CEO of Radar Logic (www.radarlogic.com). According to Feder, “Not only are the immediate signs inconclusive, but the broad dynamics are still quite scary. We think housing is still a short.” The point is that the potential financial reward of buying a home is a resounding “maybe.”

• The tax advantages of home ownership are compelling because mortgage interest is tax-deductible, gains are normally tax-free, and the definition of a personal residence is very broad.

It is a fact that residential mortgage interest is technically a tax-deductible item. The opportunity to deduct mortgage interest effectively lowers the cost of borrowing. However, only those taxpayers who itemize their deductions (70 percent of American taxpayers take the standard deduction, according to The Tax Policy Center) will receive any tax benefits from their mortgage interest. IRS Publication 936 “Home Mortgage Interest Deduction” (www.irs.gov) covers all of the requirements.

The other huge potential tax break relative to home ownership arises when a personal residence is sold at a gain. Many taxpayers are unaware of the very generous rules that often exclude from federal income tax a gain realized from selling a home. There is no longer any requirement to reinvest the proceeds into another residence of equal or greater value or to be a certain age to exclude the gain. The rules are really quite simple. If the home has been owned and used as the taxpayer’s principal residence for an aggregate of two of the last five years, any gain up to $250,000 for individuals ($500,000 for joint filers) is tax-free. If the two-year test is not met due to extenuating circumstances, including a change of employment, health or “unforeseen circumstances,” a portion of the gain may still be excluded. Be sure to check out full the details found in IRS Publication 523 “Selling Your Home” before proceeding with any sale.

Most of the tax benefits of home ownership are extended to second residences as well. The Internal Revenue Code stipulates that if a facility includes a place to sleep, a toilet and cooking facilities, it qualifies as a residence. This definition thus could fit a variety of homes, including a boat or a recreational vehicle.

Is home ownership still a valuable financial tool for most of us? Consider the comments of Greg McBride, a senior analyst at Bankrate.com: “Home ownership is not so much a creator of wealth as a store of wealth. The promise of home ownership is that over the long haul it can rebate many or perhaps all of your costs, unlike rent, which doesn’t rebate a dime.”

In my next column, we will unpack and analyze the most commonly noted disadvantages of owning versus renting.